Curbing Corporate Debt Bias: Do Limitations to Interest Deductibility Work?

Ruud de Mooij and Shafik Hebous

No 6312, CESifo Working Paper Series from CESifo

Abstract: Tax provisions favoring corporate debt over equity finance (“debt bias”) are widely recognized as a risk to financial stability. This paper explores whether and how thin-capitalization rules, which restrict interest deductibility beyond a certain amount, affect corporate debt ratios and mitigate financial stability risk. We find that rules targeted at related party borrowing (the majority of today’s rules) have no significant impact on debt bias—which relates to third-party borrowing. Also, these rules have no effect on broader indicators of firm financial distress. Rules applying to all debt, in contrast, turn out to be effective: the presence of such a rule reduces the debt-asset ratio in an average company by 5 percentage points; and they reduce the probability for a firm to be in financial distress by 5 percent. Debt ratios are found to be more responsive to thin capitalization rules in industries characterized by a high share of tangible assets.

Keywords: corporate tax; capital structure; debt bias; thin capitalization rule (search for similar items in EconPapers)
JEL-codes: G32 H25 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-acc and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Curbing corporate debt bias: Do limitations to interest deductibility work? (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_6312

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